I joined Peggy Tuck this morning on Straight Talk Money. Given that Berkshire Hathaway just had its annual meeting, we have Buffett on the brain. We discuss Warren Buffett’s career and a few things you might not know about the Oracle.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

Warren Buffett doesn’t spend a lot of time talking about “the market,” and he certainly doesn’t try to time it. As a “bottom-up” investor that looks at individual companies, that’s not his game.

Or at least that’s what you think. The truth is, Mr. Buffett has had quite a bit to say over the years about “the market.” Buffett is no dummy. He’s well aware that as the market goes, so go the valuations of the vast majority of stocks that make up the market, including his own, Berkshire Hathaway(BRK-A).

I’ll never forget an article he wrote for Fortune in 1999 (see “Mr. Buffett on the Stock Market”). I was a senior in college…and already dreaming of making millions in the stock market. It was the 1990s, and anything ending with “dot com” was an instant goldmine.

When Warren Buffett—a man I considered a hero—had the audacity to say that stock returns going forward would be disappointing, I felt betrayed…even insulted. Clearly the old man had lost his touch.

Naturally, I didn’t listen to the Sage of Omaha…and I lost a lot of money as a result in the crash that quickly followed. It was a lesson well learned.

But Buffett’s words sixteen years ago are every bit as insightful today as they were then. Buffett argued that in order for investors to earn anything close to historical returns in the market the following two conditions would have to hold:

Interest rates must fall further.

Corporate profitability in relation to GDP must rise.

In 1999, Buffett considered both of those scenarios unlikely, though he acknowledged that “If government interest rates, now at a level of about 6%, were to fall to 3%, that factor alone would come close to doubling the value of common stocks.”

Well, rates have obviously fallen a lot further than that, and the market hasn’t exactly doubled from 1999 levels. The market is up about 40% from the old dot-com-era high. But Buffett’s point was well made. Lower rates have allowed for much higher stock valuations.

On the second count, corporate profits, the ever-quotable Buffett wrote:

You know, someone once told me that New York has more lawyers than people. I think that’s the same fellow who thinks profits will become larger than GDP. When you begin to expect the growth of a component factor to forever outpace that of the aggregate, you get into certain mathematical problems. In my opinion, you have to be wildly optimistic to believe that corporate profits as a percent of GDP can, for any sustained period, hold much above 6%.

Well, so much for that. As you can see in the chart, courtesy of the St. Louis Fed, corporate profits have now nearly doubled the levels that Buffett believed to be unsustainable.

But while Buffett might have been a little off on the numbers, his logic was pretty solid. Companies cannot continue to take an ever-bigger slice of the economic pie. Eventually, this creates political backlash, as we see today. The basic laws of economics also start to rain on the parade. High profits attract competition…which crimps margins and ultimately lowers profits.

Today, market rates across the yield curve are near historic lows. They cannot realistically go much lower, unless temporarily during a crisis. And at the same time, corporate profits as a percentage of GDP are at all-time highs. None of this means the market is due to crash tomorrow, but it tells me that we should have realistic expectations about future returns. A strategy of buying and holding U.S. equities isn’t likely to offer much in the way of returns going forward. If you’re going to earn anything resembling a respectable return, plan on taking a more tactical approach and looking outside your normal comfort zones.

My advice is to focus on absolute returns strategies and on generating cold, hard cash in the form of dividends. To the extent you look for “beta” risk in the market, focus overseas. Valuations are far more reasonable in Europe and in most emerging markets.

Charles Sizemore is the principal of Sizemore Capital Management. As of this writing, he had no position in any security mentioned.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

It’s that time of year again. Warren Buffett’s Berkshire Hathaway (BRK.A, BRK.B) just released its latest 13F filing, which outlines its buys and sells over the past quarter.

While this data is always a little bit dated by the time it is released (Berkshire’s reporting date is Sept. 30) and it does not take into account non-traded securities, derivatives or short positions, these issues matter relatively little in the case of Warren Buffett.

The Oracle, after all, is known for taking large, concentrated positions and holding on to them for a while.

What Warren Buffet Has Been Buying and Selling

As of quarter end, Berkshire Hathaway had made a large new investment in Exxon Mobil (XOM) worth $3.5 billion, boosted its existing position in dialysis provider DaVita HealthCare Partners (DVA) by nearly a quarter, and reduced his holdings in ConocoPhillips (COP) and GlaxoSmithKline (GSK)

And since quarter’s end, Warren Buffett has been busy. Berkshire added yet more shares of DaVita on Nov. 8 and initiated a new position in Goldman Sachs (GS) on Oct. 8.

What It All Means

To start, Buffett still is bullish on financials. Financial services represent nearly 40% of the Berkshire traded stock portfolio, led by Wells Fargo (WFC), which alone accounts for 21% of the portfolio. Buffett is holding tight to IBM (IBM), his largest recent investment, despite its terrible performance this year. And Buffett — or one of his lieutenants — still is very bullish on DaVita’s dialysis business, despite its dependency on Medicare as a payer.

I’m not privy to Berkshire Hathaway’s investment committee meetings, but it’s not hard to understand their bullishness. Dialysis is a business that is anything if not predictable. Patients must have the procedure done regularly, and there are generally only two ways off: a transplant or death.

Earlier this year, DaVita got a kick to the teeth when Medicare proposed reducing its payments by over 9%. Medicare and Medicaid together account for about two-thirds of revenues. But demographic trends practically guarantee that DaVita’s revenue stream will explode in the years ahead, even if margins are somewhat crimped.

Kidney disease can affect any American at any age, but it is a bigger problem among the middle-aged and elderly. According to the Kidney End-of-Life Coalition, 45% of the more than 320,000 patients receiving dialysis therapy in the United States are over the age of 60, and the fastest growing segment of the dialysis population to be among patients aged 75 and older.

Meanwhile, the largest cohort of the baby boomers still are in their early 50s and not too far removed from their physical prime. But the front end of this generation is in its late 60s, and with every passing year a larger number of baby boomers find themselves at risk of chronic diseases like kidney disease.

Buffett and his team appear to be betting that these demographic forces will outweigh the effects of a stingier Medicare program.

I, for one, agree.

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities. Click here to receive his FREE 8-part investing series that will not only show you which sectors will soar, but also which stocks will deliver the highest returns. This series starts Nov. 5 and includes a FREE copy of his 2014 Macro Trend Profit Report.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

It’s that time again. Warren Buffett’s Berkshire Hathaway (BRK-A) released its quarterly 13F filing today, which details stock by stock what Buffett and his managers have been buying and selling.

At the top of the list? A 17.8-million-share position in Suncor Energy (SU), Canada’s biggest oil and gas producer. Suncor is a major producer in the Alberta oil sands, and this purchase is consistent with Buffett’s overall belief in a North American industrial renaissance.

Next is Dish Network (DISH), the satellite television provider. Berkshire Hathaway added 547,312 shares of Dish, worth about $24 million. The relatively small size of the acquisition indicates it was probably made by one of Buffett’s lieutenants and not the Sage himself. Still, given that Buffett’s two managers—Todd Combs and Ted Weschler—are front runners to take control of Berkshire Hathaway’s portfolio once Buffett eventually retires, the move is worth noting.

Dish is an odd addition for Berkshire Hathaway given that archrival DirecTV (DTV) is already in the portfolio and has been for a few years now. It’s even stranger when you consider the high drama surrounding Dish and its CEO Charlie Ergen and its failed bid to purchase Sprint (S) and Clearwire for their spectrum assets.

Ergen had grand ambitions of using Sprint’s bandwidth to create something of a wireless empire that would have included paid TV, phone service, and wireless internet…which sounds great, except that he would have been entering an already crowded market in all three services. And in any event, he got outbid.

Buffett is not known for endorsing great jumps into the unknown. Dish seems an odd addition to a generally conservative, staid portfolio. It’s highly-indebted, not particularly cheap, and operates in an industry in the middle of a transformation with a very uncertain outcome. I’m left scratching my head on this one.

In addition to Dish and Suncor, Buffett massively increased his position in General Motors (GM), adding about 60% to a position now worth $1.4 billion. Like Suncor, this move is more in line with Buffett’s belief in America’s industrial future. It’s also an established player in an old-line industry trading for a reasonable price. Classic Buffett.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

For those unfamiliar with Howard Marks, he is the Chairman and cofounder of Oaktree Capital Management, an investment firm with $77 billion under management. The Most Important Thing Illuminated, published in 2013, is an update to Marks’ original, published in 2011, though in Illuminated Marks has help. Greenblatt, managing partner of Gotham Capital and author of The Little Book That Beats the Market, offers his own commentary throughout the pages, as do Christopher Davis, portfolio manager of the Davis Large Cap Value fund, and Seth Klarman, president of The Baupost Group and a well-respected value investor. Marks keeps good company.

I had high expectations when I picked up The Most Important Thing Illuminated, and I wasn’t disappointed. This isn’t yet another “how to invest” book or a tired rehashing of received investment “wisdom” that looks more like something found in a fortune cookie and which rarely seems to hold up in practice.

Instead, Marks gives us the insightful thoughts of a man who struggles with his own investing decisions on a daily basis. There are no shortcuts, formulas, or easy tricks. But there is a wealth of experience and thoughtful contemplation from a real “in the trenches” investor who has been doing this a long time.

Marks starts the book with a chapter on “second-level thinking,” and I consider this one of the most valuable lessons in the entire book. Having a good understanding of this chapter alone will put you head and shoulders above most of your peers.

Mechanical trading rules work really well…right up until the point that they don’t. And why don’t they work consistently over time? As Marks explains,

The reasons are simple. No rule always works. The environment isn’t controllable, and circumstances rarely repeat exactly. Psychology plays a major role in markets, and because it’s highly variable, cause-and-effect relationships aren’t reliable. An investment approach may work for a while, but eventually the actions it calls for will change the environment, meaning a new approach is needed. And if others emulate an approach, that will blunt its effectiveness.

Investing, like economics, is more art than science. And that means it can get a little messy.

“Messy” is not a technical term, but it is accurate and descriptive hear. Markets are driven by people and by ever-changing real-world events. Trying to cram this into a mechanical trading model or a black box is a recipe for disaster. And frankly, it’s mentally lazy and reflects an unwillingness (or inability!) to grasp complexity.

This brings me to Marks’ points about second-level thinking. What exactly is “second-level thinking.” Perhaps it is best explained by example:

“First-level thinking says, ‘It’s a good company let’s buy the stock.’ Second-level thinking says, ‘It’s a good company, but everyone thinks it’s a great company, and it’s not. So the stock’s overrated and overpriced; let’s sell.’”

“First-level thinking says, ‘I think the company’s earnings will fall; sell.’ Second-level thinking says, ‘I think the company’s earnings will fall less than people expect, and the pleasant surprise will lift the stock; buy.’”

Call it contrarian thinking, applied game theory, or just being clever, but this is the mindset that is required to be a successful investor over time. It’s also a skill that few investors have or have the mental discipline to use.

It’s not easy going against the grain and taking views that are contrary to the consensus. But then, no one ever said that investing should be easy.

Market Technicals and Psychology

As a value investor, Marks is not a fan of technical analysis (i.e. charting) but he does stress the importance of understanding what he calls “market technicals,” or non-fundamental factors that affect the supply and demand for a security. Failing to understand these can lure an investor who looks at value alone.

What are some examples? Marks lists two specifically: the forced selling that takes place when a market crash trips margin calls, which forces leveraged investors to sell at any price, and the cash inflows that go to mutual funds that are usually invested irrespective of price. To these I would add short squeezes, secondary stock price offerings that dilute shareholders, and buyout offers.

These technical factors are often closely related to market psychology. And as Marks writes, “The discipline that is most important Is not accounting or economics, but psychology…

Investing is a popularity contest, and the most dangerous thing is to buy something at the peak of its popularity. At that point, all favorable facts and opinions are already factored into its price, and no new buyers are left to emerge.

Need an example? Think of Apple’s performance over the past few years. Apple was the “must own” stock of the 2010s. Everyone owned it—individual investors, mutual fund managers, hedge fund managers…you name the investor, and chances are good that Apple made up a good-sized chunk of their portfolio.

There were cases of focused hedge funds having 20-30% of their portfolio in Apple. Even now, after Apple’s massive slide, the stock accounts for nearly 15% of the Technology Select SPDR (NYSE:$XLK), one of the most popular ETFs for investing in the tech sector. Apple’s position in the ETF is bigger than Google’s and IBM’s combined.

It’s not a figure of speech to say that there was no one left to buy Apple. No matter how great a company is, there is a limit to how high a percentage of investors’ portfolios it could comprise.

And we all know what followed. Apple’s share price fell by over 40%, and may or may not be finished falling.

A pure value investor wouldn’t have seen the risk in Apple. Based on popular metrics such as price/earnings or price/sales, Apple wasn’t particularly expensive. It actually looked pretty cheap compared to the broader market.

But if you had taken market technical and investor psychology into account, you would have known to be wary. You almost certainly wouldn’t have timed the top perfectly, but you would have known that caution was warranted.

Unfortunately, as Marks acknowledges, “psychology is elusive…and the psychological factors that weigh on other investors’ minds and influence their actions will weigh on yours as well.”

There are no shortcuts here. You have to remain as dispassionate as possible and, where possible, try to apply second-level thinking.

Thoughts on Risk

Risk is one of the most difficult concepts in investing because it is impossible to quantity. Yes, we have measures such as standard deviation, variance, or beta, but these measure volatility. Volatility and risk are not at all the same thing.

A better definition of risk is the possibility of loss. But even this is hard to define or quantify in any meaningful way. And at the time when a stock appears the most risky—such as after a recent volatile drop—it may actually be relatively less risky, as the selloff shook out the less committed investors. And on the flip side, it is when a stock looks least risky—think Apple this time last year—when it is in fact most at risk.

And it gets more complicated than that. You can’t gauge the riskiness—or the quality—of a trade based on what happened. You have to base it on what could have happened.

In other words, you can take a phenomenally bad gamble with negative expected returns and still come out ahead. But that doesn’t mean it was a good decision. Let me state it bluntly: A good outcome does not mean that the decision that led to it was a good one.

If you don’t understand what I’m talking about, you should probably stop reading. And you should definitely stop investing.

Winning the lottery is a fantastic outcome. But the expected value on any given lottery ticket is negative because the possibility of a payoff is infinitesimally small. Most people would agree that winning the lottery is good luck. But, being overconfident in their own abilities, they fail to see the role of luck in good investment returns based on bad trading.

Marks, in thinking very similar to that of Black Swan guru Nassim Taleb, does a good job of explaining this:

A few years ago, while considering the difficulty of measuring risk prospectively, I realized that because of its latent, nonquantitative and subjective nature, the risk of an investment—defined as the likelihood of loss—can’t be measured in retrospect any more than it can a priori.

Let’s say you make an investment that works out as expected. Does that mean it wasn’t risky?… Perhaps it exposed you to great potential uncertainties that didn’t materialize….

Need a model? Think of the weatherman. He says there is a 70 percent chance of rain tomorrow. It rains; was he right or wrong?

It’s easy to get overly academic here and veer off into directions that are not particularly practical. Perhaps it can be summed up with the old Wall Street adage to “Never confuse brains with a bull market.”

More broadly, we should always remember that risk is a complicated concept and that we can’t get complacent in our investment process. When you have capital at risk, you need to be vigilant.

Does this mean we should avoid risk? Not at all. As Marks puts it, “risk avoidance is likely to lead to return avoidance.” Assuming risk is part of the investment game. It is just a matter of keeping risk under control and making sure that the returns we realistically expect are worth the risk we are taking.

On Cycles

While Marks eschews charting and most forms of technical analysis, he does have respect for market cycles. In fact, he offers two rules for investing with a mind to cycles:

Rule number one: Most things will prove to be cyclical

Rule number two: some of the greatest opportunities for gain and loss come when other people forget rule number one.

Marks’ interest in cycles ties back to his belief in the importance of market psychology:

Objective factors do play a large part in cycles, of course—factors such as quantitative relationships, world events, environmental changes, technological developments and corporate decisions. But it’s the application of psychology to such things that causes investors to overreact or underreact and thus determines the amplitude of the cyclical fluctuations…

Cycles are self-correcting, and their reversal is not necessarily dependent on exogenous events. They reverse (rather than going on forever) because trends create the reasons for their own reversal. Thus, I like to say success carries within itself the seeds of failure, and failure the seeds of success.

Well said. Marks’ views are consistent with those of Hyman Minsky, who believed that stability inevitably leads to instability (and vice versa) because stability encourages risky behavior and instability prompts more sober behavior.

Within the markets, a long period of stability and growth leads investors to assign higher and higher earnings multiples to stocks—think of the 1980s and 1990s. But during long periods of economic malaise and market turmoil, investors assign lower and lower earnings multiples. This cycle is probably the one permanent fixture throughout the history of the capital markets.

Marks offers so specific trading strategy to trade cycle fluctuations; his intent is simply to offer a word of advice to not ignore them.

In this book review, I have barely scratched the surface of The Most Important Thing. This book is chocked full of very accessible, very down-to-earth investment advice, and the praise heaped on it by Buffett, Klarman and the rest is well deserved. This is a book that I recommend you keep on your desk and thumb through on those days where the market isn’t making sense and you need a little grounding.

Compliments on a book well written.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.